Painless Starts

This note was originally published
at 8am on April 22, 2015 for Hedgeye subscribers.

“The marvelous thing is that it’s painless.”

-Ernest Hemingway

In one of my favorite Hemingway short stories on mortality (The Snows of Kilimanjaro), that’s how a dying man explained the beginning of the end to his wife.

“That’s how you know when it starts”, he said. “It’s painless.”

To be clear, I don’t mean to bug you out this morning. I just wanted to remind you that while it’s been painless to be long of Chinese, Japanese, European (and now, on the margin, American) “easing” (in bond/stock market terms), this won’t end well.

Back to the Global Macro Grind…

‘How could you write such a thing? Et tu, brute? How can you be bullish for the last leg of this ramp and, at the same time, remind me how it all ends? I knew it Mucker… you are a perma bear! You bastard.’

Enough of my literary attempts to entertain you, eh. Let’s just stick with the data (and some hilarious headlines for this stage of what’s been nothing short of an epic inflation of global stock and bond market prices):

Chinese “investors” open a record number of stock brokerage accounts week-over-week (Sina.com)

Storytellers have been trying to become famous writing about the Flash Crash for years

Oh, and if you didn’t think Greek stock market risks were real, you’re losing money long that

Since I haven’t had one real Institutional Investor ping me on the latest trader to sport the orange jump-suit risk for flash crashing the party (for a day), I give you a few more fun facts about Chinese and Greek stocks, instead:

CHINA: since growth and inflation really started slowing in OCT, the Chinese stock market is +92%

In Hedgeye-speak, that makes China a bullish intermediate-term TREND and Greece a bearish one. If intermediate-term (3 months or more = TREND duration) is too short-term for you, look at both of these country stock markets year-over-year:

CHINA: Shanghai Composite Index = up +112%

GREECE: Athens General Share Index = down -44%

“So”, what I’d really need to get bullish on Greek stocks is:

The Greeks telling the world the half truth (like China did) about slowing growth and #Deflation

The Germans confirming that they get the truth, but have no intention of letting Greece “exit”

And the mother of all Greek bailouts right when CNBC/Bloomberg are as bearish as they were on China last year

The death of the lies is where the painless progression starts, no?

It worked in Ireland and Iceland (sort of). And while I completely disagree with the policy to bailout losers, my political view on that front would have rendered my research opinions useless for the last 5-6 years too.

Can you imagine being the “smartest” man on earth right now (per yourself) and short Chinese stocks from last year’s lows? There is nothing painless about hubris. And I’ll define that in market terms for you too – not respecting Mr. Macro Market’s message.

I’ve lived and learned through this entire central planning circus alongside you, writing and ranting about it, almost every day for 7 long years…

I’ve always thought this won’t end well. But “ends” are processes, not points. And I’ve tried to time the beginning of the end as painlessly as possible. Because realizing perpetual P&L pain is no way to live.

Front-running A Bad Jobs Report?

Client Talking Points

ASIA

Asia is not a headline story (yet) but our model is signaling multiple breakdowns across Eastern stock markets. Indonesia broke a few weeks ago and India’s (BSE Sensex) recent breakdown was confirmed overnight with another -2.3% drop to -2% year-to-date. Australia cut rates and its stock market dropped -2.3% (with Commodities up!). The Shanghai Casino Composite is -5.6% in 2 days #MarginCalls.

RUSSELL 2000

The Russell 2000 does not like Down Dollar, and that makes sense to us as the “tax cut” from lower gas prices is, well, getting cut! This is going to be a problem for a narrative that even Janet Yellen has recently been forced to acknowledge (#StrongDollar, Down Oil, Stronger Consumption). The Russell 2000 is in the midst of a -4.7% correction – overlay that with what’s happening with the USD and you’ll get the point.

Asset Allocation

CASH

53%

US EQUITIES

6%

INTL EQUITIES

8%

COMMODITIES

0%

FIXED INCOME

31%

INTL CURRENCIES

2%

Top Long Ideas

Company

Ticker

Sector

Duration

RH

The Russell 2000 does not like Down Dollar, and that makes sense to us as the “tax cut” from lower gas prices is, well, getting cut! This is going to be a problem for a narrative that even Janet Yellen has recently been forced to acknowledge (#StrongDollar, Down Oil, Stronger Consumption). The Russell 2000 is in the midst of a -4.7% correction – overlay that with what’s happening with the USD and you’ll get the point.

ITB

iShares U.S. Home Construction ETF (ITB) is a great way to play our long housing call. Builder performance was choppy in the latest week alongside beta volatility and investor attempts to square the net impact to housing from rising rates and ongoing improvement in housing fundamentals. As it stands currently, rates remain a tailwind to affordability relative to last year and would require a significant, expedited increase to have a material negative impact on housing activity in the immediate/intermediate term. Elsewhere across Housing Macro, the fundamental data continued to roll in strong.

TLT

Insomuch as the April Jobs Report may prove to be a bearish catalyst for Treasury bonds, slowing growth data over the next two quarters should prove decidedly bullish. Fighting buy-side consensus on the long side of Treasury bonds been a great call thus far so we’d be booking gains and taking down our gross exposure to this asset class on the next immediate-term pop. Ultimately, we think our #LowerForLonger theme prevails, but volatility is likely to pick up in the interim.

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What Didn't Work?

If you analyze every line item of what I like and don’t like right now, there are plenty of things that aren’t working. Unless you’re raging Long Chinese stocks and Commodities vs. Short US/European Stocks (and Bonds), you probably have some issues too.

In the last week the US Dollar has completely dislocated from what was a consistent and correlated moved with US interest rates. What was the #StrongDollar Deflation (one of the biggest macro moves in a decade) has morphed into Down Dollar, Up Rates.

But is the US Dollar down ahead of another weak US jobs report? Or are Rates Up ahead of a good one? I can’t give you 10,000 different ways to ask me those two very basic questions – but in the last week, I’ve fielded hundreds of them!

Back to the Global Macro Grind…

Some people say that part of the value I provide is my unique perspective. Unlike many macro economists, strategists, and chartists, I am a former hedge fund guy who has made almost every mistake you can make, using live ammo.

Setting aside all of my human flaws, I think most of you (buy-siders) can empathize with getting things wrong. It’s only on the sell-side where the pace of improvement in Macro Strategy has been stalled by not accepting mistakes and learning from them.

As one of the bigger buy-siders (Ray Dalio) wrote in Principles: “At Bridgewater, we created a culture in which it is ok to make mistakes, but unacceptable not to identify, analyze, and learn from them.”

Roger that, Ray.

One of the mistakes I made recently was underestimating how our fundamental research call (#LateCycle Growth Slowing) would impact the USD/Oil trade.

From an intermediate-term TREND perspective, I thought Oil (WTI) would settle into a range of $36-57/barrel. This morning, on another Down Dollar move, Oil is up another +2.5% to $61.91.

You can apply creative writing skills from your no-buy-side-P&L-experience all you want, but from where I was born/raised in this business, this is commonly called being wrong (until you have the mental humility to change your mind).

To be clear, my mistake wasn’t being short Oil for this entire move up (we covered commodity shorts ahead of an easier Fed and #LateCycle Labor reports, for a trade). It wasn’t being long it at $100 either. It was in not being long it from $45 to $62.

My main mistake there was that I didn’t think Oil’s Volatility was going to compress almost as fast as it exploded to the upside. To put the volatility of volatility (in Oil) in context:

From SEP 2014 to FEB 2015, Oil Volatility (OVX) went from 17 to 63 = +270%

From FEB 2015 to now, OVX dropped from 63 to 36 = -42%

Every buy-sider who survived the 2007-2009 gets that unless you were on the right side of the decline, it was hard to run out and buy something with historical volatility of 20-30, never mind 63. This #behavorial reality leads me to more of a question (from here) than an answer as to whether or not I should buy Oil with upside to $69.03, when the downside is still $42.06.

Did the guys/gals who bought Oil and its cyclically related inflation expectations exposures (E&P MLP stocks, Energy Junk Bonds, Levered Long Oil Futures, etc.) down at $45 own it from $90 to $45? Or are we talking about a whole new investor class who nailed it both ways? While I’m not certain about anything in this profession, I’m pretty sure long-term Oil bulls averaged in.

Of all the mistakes I’ve made, averaging into losers is by far the most punishing. Especially when I’d have our funds in smaller cap exposures, doubling and tripling down on mistakes could make them all the more severe. Sure, I could tell my partners that I wasn’t wrong. I could say I hadn’t really failed (yet). But the #truth happens on the next decline, when you can’t get out.

When my Global Macro model says lower-for-longer on both US and Global Growth Rates… and every central planner on the planet is trying to “ease” the confusion implied in the volatility of the aforementioned risk ranges, what works for me isn’t adding to my mistakes; raising Cash does. And I’ll do that again this morning in the Hedgeye Asset Allocation Model.

May 6, 2015

BULLISH TRENDS

BEARISH TRENDS

WTW: Don’t Care Until 2016 (1Q15)

Takeaway:This story doesn’t get interesting again till we get closer to 2016. But the bigger question now is whether mgmt can stave off Chapter 11.

KEY POINTS

UNEVENTFUL PRINT: Mgmt already conceded 2015 was going to be a rough year when it disappointed on 2015 guidance. While the print was relatively uneventful with a slight top-line miss on Fx, and reiterated guidance, the key takeaway from the print was that the 2015 winter selling season was in fact its worst winter selling season in its public history.

DON’T CARE UNTIL 2016: Our tracker is showing decent improvement into 2Q15, but that doesn’t matter all that much. The first quarter sets the tone for any given year given WTW’s seasonal attrition issues. That said, no quarter in 2015 will change the tide from here, and 2015 is largely irrelevant outside of tracking seasonal attrition patterns, which at a minimum appear to be approving.

CHAPTER 11? WTW is dangerously approaching the point where it costs more to acquire its members than the gross margin it earns from them. If that ever happens, it’s basically game over. WTW’s 2015 target of $290M in cash can only go so far with an annual debt service of roughly $120M. For more detail, see the note below.

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